All employed workers, whether they work for a company or are self-employed, must pay their taxes based on the income they have earned or received. A person must pay the federal government on a “pay-as-you-go” basis for their taxes, which is done through withholding or estimated taxes. For employed taxpayers, their withholding taxes are deducted from their pay checks. However, self-employed individuals must provide an estimated tax payment for the year on income that is not subject to withholding. The estimated taxes goes to self-employment and federal income tax.
Are You Self-Employed?
According to the IRS, a person who is self-employed:
- Has a trade or business as a sole proprietor or an independent contractor;
- Is a member of a partnership or limited liability company that carries on a trade or business; or
- Is in business for themselves, such as having a part-time business in addition to a regular job.
What is the Self-Employment Tax?
Self-employment tax or SE is a tax paid by self-employed people. It is derived from the net income that they have earned from their own business. An individual’s net income is what’s left after the allowable business expenses have been deducted from the gross income.
The rate for SE tax is 15.3%; 12.4% of which is for Social Security and the rest, 2.9% is for Medicare. All self-employed people must pay the SE tax regardless of how much they earn; but those with income exceeding a certain amount are not subject to the Social Security tax. The taxpayer can further reduce their income tax by deducting half of the SE tax from the adjusted gross income.
Who Must Pay Estimated Taxes?
The estimated taxes cover SE and income tax. If sole proprietors, partners and S corporation shareholders expect to owe $1,000 or more in federal taxes for the year, then they must pay estimated taxes. It corporations expect to owe $500 in federal taxes for the year, then they must also pay estimated taxes.
Who Does Not Have to Pay Estimated Taxes?
You may not need to pay estimated taxes if:
- You were not a U.S. citizen or resident for the entire year
- You had no tax liability in the previous year (you did not have to file a tax return or your tax liability was zero)
- Your tax return in the previous year did not cover a full 12 months
How to Calculate Estimated Taxes
You may risk assessment and penalties from the IRS if you fail to pay enough in estimated taxes. In order to calculate for estimated taxes for the year, you may use the previous year’s tax return.
To avoid penalties, a taxpayer must be able to pay at least the equivalent of:
- 90% of the total tax liability for the current year
- 100% of the tax liability for the previous year (or 110% for high-income taxpayers)
When to Pay Estimated Taxes
The payment of estimated taxes may be paid in four installments. The following shows the installment periods set by the IRS and the corresponding due date for the estimated taxes.
|Income Earned During the Period||Estimated Tax Due|
|January 1 – March 31||April 15|
|April 1 – May 31||June 15|
|June 1 – August 31||September 15|
|September 1 – December 31||January 15 of the next year|
The IRS does not require the payment of the estimated taxes until the income has actually been earned by the taxpayer. If an income is earned during a certain period, the estimated tax for that income is due on the installment due date for that period; it can also be paid in installments. However, if the taxpayer did not earn any income within a certain period, then they do not need to pay estimated taxes for that period.
How to Pay Estimated Taxes
There are several ways to pay for estimated taxes:
- Sending in the payment with Form 1040-ES
- Paying electronically through the Electronic Federal Tax Payment System (EFTPS)
- Crediting an overpayment from the previous tax year to the estimated tax liability
- Paying by credit card over the phone or through the Internet
- Paying by Electronic Funds Transfer when electronically filing a tax return
IRS Penalties for Underpaying Estimated Taxes
The taxpayer risks being charged with penalties if they underpay their estimated taxes. One penalty could be an underpayment penalty, which is for underpayment or failure to pay estimated taxes within the required period. The penalty is assessed as a daily percentage which could range from 6% to 8% of the unpaid underpayment.